[author: Kim, Lesley]
On November 11, 2012, Canada signed a tax treaty1 with Hong Kong (the “Tax Treaty”). Some may find it surprising, given the level of trade between Canada and Hong Kong and the number of Hong Kong residents who have immigrated to Canada, that Canada did not previously have a tax treaty in place with Hong Kong. Canada has had a tax treaty with China for a number of years, but it did not include Hong Kong.
In the past, Hong Kong residents would have to implement complex structures through countries having tax treaties with Canada in order to minimize Canadian taxes and/or avoid double taxation. Otherwise, residents of Hong Kong previously wishing to carry on business or invest in Canada would be subject to Canadian tax on all income earned in Canada at the applicable Canadian tax rates (up to 31% combined federal and provincial tax for corporations) and to a withholding tax of 25% on dividends, interest and royalties, in addition to any Hong Kong taxes they may be subject to.
A Hong Kong resident could be carrying on business in Canada simply by selling goods in Canada or by servicing equipment in Canada. Once the Tax Treaty comes into force, business income earned by a Hong Kong resident in Canada will only be taxed in Canada, to the extent that such income is earned through a “permanent establishment” in Canada. A Hong Kong resident will generally have a permanent establishment in Canada if he, she or it has a physical presence in Canada, such as an office, store or other location through which business is carried on.
The Tax Treaty may not have as much of an impact on Canadian residents investing in Hong Kong. Hong Kong does not have a withholding tax on dividends or interest and its corporate tax rate is relatively low at 16.5%. However, residents of Canada wishing to carry on business or invest in Hong Kong would previously still be subject to Hong Kong tax on any income derived from or arising in Hong Kong at the applicable Hong Kong tax rate and to a withholding tax of up to 16.5% on royalties, in addition to any Canadian taxes they may be subject to.
As with Hong Kong residents carrying on business in Canada, once the Tax Treaty is in force, Canadians earning business income in Hong Kong will only be taxed to the extent that such income is earned through a permanent establishment in Hong Kong.
Recently, Canada has included a limitation of benefits article in their tax treaties. Where tax treaties include a limitation of benefits provision, residents of a treaty country could generally only benefit under the treaty to the extent that they are true tax paying residents of that country. The Tax Treaty with Hong Kong does not contain a limitation of benefits article which means that a person generally only needs to be a resident of Hong Kong to benefit under the Tax Treaty.
Under the Tax Treaty, Hong Kong residents receiving dividends from Canada will be entitled to a reduced dividend withholding rate of 5% when dividends are paid to a corporation that controls at least 10% of the capital of the payor corporation, and, in any other case, to a reduced withholding rate of 15%. The Canadian withholding rate will be reduced to 10% under the Tax Treaty on interest and royalties paid to Hong Kong residents. Arm’s length interest is generally not subject to Canadian withholding tax, even without a tax treaty, but the 10% rate will be welcome in non-arm’s length situations.
Since Hong Kong does not tax dividends or interest, as in the past, no tax will be withheld from dividends or interest paid to Canadian residents. However, the Hong Kong withholding rate on royalties will be reduced to 10% under the Tax Treaty.
As with most of Canada’s tax treaties, the Tax Treaty includes an exchange of information article. This means that Canada could request information from Hong Kong with respect to Canadian residents for Canadian tax purposes, and vice versa.
The Tax Treaty will come into force following the ratification procedures in both Canada and Hong Kong.
1. Agreement between the Government Of Canada and the Government of the Hong Kong Special Administrative Region of the People’s Republic of China for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income.